MH Corporate

Thursday 27 September 2012

Changes to the UK security registration regime

In August 2012, draft regulations were published by the Department for Business, Innovation and Skills (BIS) to amend the current procedure for registration of security at Companies House. The draft regulations seek to overhaul the existing regime for registering security created by companies and LLPs in the UK.

The draft regulations purport to: (i) implement a UK-wide system of registration; (ii) introduce electronic filing; (iii) remove criminal sanctions for failure to register a registrable security (although this does not affect issues surrounding the enforceability of such security); (iv) introduce an assumption that all security can be registered; and (v) improve access to information regarding a company’s security.

The main intention of the proposed changes is to modernise and streamline the security registration regime.

The most notable change to the regime is that non-registration of security is no longer subject to criminal sanction. The regulations now refer to the obligations of the Registrar, rather than the company, LLP or person interested in the security. The language has been left so that the onus is on the presenter of the security to determine whether it should be registered. However, unregistered security would still be invalid against a liquidator, administrator or creditor in the same way as before, and so registration is still advisable in almost every situation. The 21 day deadline, sanctions for failure to notify Companies House regarding enforcement action and the need to retain a copy of the security will each remain in place.

The draft regulations state that security will be registrable electronically. A certified copy of the security document may be filed in this way, together with brief particulars. The certificate issued by Companies House will only be proof that the security was filed within the permitted time period.

A new provision of particular note is that the full text of the security document will now be available at Companies House, subject to redaction of personal information (but not commercially sensitive information). The purpose of this is to increase transparency and ease of access to information.

The draft regulations are the result of several consultations since 2010. They should make the regime more user-friendly, with information regarding the security created more accessible and readily available to the public. Final consultation was due in early September and it is expected that the regulations will come into force on 6 April 2013. BIS and Companies House guidelines are expected in the new year.

The decision in Porton Capital Technology Funds and others v 3M UK Holdings Limited and another 2011] EWHC 2895 (Comm)) demonstrates how having an earn out as part of the purchase price calculation can go wrong.

US multinational 3M offered to acquire Acolyte, the target business, for an initial price of £10.4 million, as it believed that Acolyte’s new product for dealing with the MRSA superbug, “BacLite”, had great commercial potential worldwide.

The deal also included an earn out which potentially would provide the sellers with further consideration equal to 100 per cent. of the revenue from worldwide sales of BacLite during 2009, up to a maximum of £41 million.

The sale agreement included terms that 3M would:

“actively market” BacLite and would “diligently” seek regulatory approval for its sale in the US, Canada and Australia;

devote the same marketing and other resources to BacLite as to its other medical products;

remunerate its sales team on the same basis as other product teams; and

not shut down the Acolyte business without the sellers’ consent, such consent “not to be unreasonably withheld”.

3M, for its part, insisted on a provision stating that it was not obliged to operate its business in a manner that increased the earn out payments.

However, after completion, matters did not go to plan. In brief, over the course of the rest of 2007 and 2008, against a background of very substantial expenditure in connection to the product by 3M, the market for BacLite began to disappear. By the end of March 2008, testing and approval for a launch in the US and Canada had been put on hold.

3M then approached the sellers for consent to shut down Acolyte in exchange for a payment of just over $1 million. The sellers however demanded the maximum earn out payment of £41 million in exchange for their consent.

3M argued that this refusal meant that the sellers were unreasonably withholding their consent, in breach of the sale agreement. The sellers however countered that 3M was in breach of the agreement because it had neither “actively marketed”, nor “diligently” sought the relevant regulatory approvals for, BacLite.

At trial, the High Court concluded that:

from March 2008, 3M was no longer diligently seeking regulatory approval in the US and was therefore in breach of the sale agreement;

from various dates between June 2008 and February 2009, 3M had ceased active marketing of BacLite, also in breach of the sale agreement; and

the sellers had not unreasonably refused consent to shut down Acolyte.

With regards to the withholding of consent, it was for 3M to prove unreasonableness, for example, that because of some ulterior motive, and not, for example, because the sellers had not weighed up 3M’s costs against their interests in the earn out.

In the absence of any sale agreement, it would have been a reasonable commercial decision for 3M to close down the business. However, the Court held that was a different issue to whether or not it was unreasonable for the sellers to withhold consent to the closure. The Court then awarded, based on its best estimate of what the actual sales of BacLite would have been, just over $2 million to the Sellers, more than double 3M’s original offer, but well short of the maximum possible earn out.

The decision highlights the uncertainties of an earn out. When negotiating the sale agreement, it is important to bear in mind what the underlying sales or other financial projections are, and what might happen to the market and the business during the earn out interval. The buyer does not want to be locked in to, or pay in respect of, an obviously struggling business.

Separately, the case also illustrates that while “consent not to be unreasonably withheld” is a legal and commercial solution often applied to allow issues to be settled during a transaction, it is an approach which could potentially pose problems in the future. At the very least, the parties should consider if there are any specific circumstances in which consent either cannot be refused or is deemed to be given.

On 5 July 2012, the Code Committee of the Takeover Panel published a consultation paper in which it proposed the removal of the ‘Residency Test’ contained in section 3(a)(ii) of the Introduction to the Takeover Code (Code).

Applicability of the Code

Generally, the Code applies to:

all public companies that have their registered office in the United Kingdom, the Channel Islands or the Isle of Man and whose shares are traded on a regulated market in the UK (i.e. not AIM or Plus-SX) or a stock exchange in the Channel Islands or the Isle of Man;

all other public companies that have their registered office in the United Kingdom, the Channel Islands or the Isle of Man and who have their place of central management and control in the UK, the Channel Islands or the Isle of Man (Residency Test); or

private companies that have their registered office in the United Kingdom, the Channel Islands or the Isle of Man and which satisfy the Residency Test, provided that their securities have been made available for subscription by the public at some point during the proceeding 10 years.

Residency Test

Under the proposals, the Residency Test will be removed so that the Code will apply to all public companies (and certain private companies as described above) that have their registered office in the United Kingdom, the Channel Islands or the Isle of Man. In effect, this will bring a number of AIM, PLUS-SX and non-quoted companies under the remit of the Code.

The Code Committee has advocated a number of advantages to the proposed amendments. These are:

investors generally understand the Code to apply to all pubic companies, especially those whose securities are quoted on a stock exchange in the United Kingdom, the Channel Islands or the Isle of Man (even if that exchange is not a ‘regulated market’);

currently, as the directors of a company are able to relocate and therefore possibly change the location of the central management of the company, this could move the company outside the scope of the Code, conceivably without the knowledge of the shareholders; and

removal of the Residency Test will result in increased certainty with regard to which companies the Code applies and the Panel will not need to try and ascertain where the central management of a company is located.

There are also arguments against the removal of the Residency Test. The main one is that it will be harder for the Panel to effectively monitor and enforce the provisions of the Code in respect of companies which are controlled outside the United Kingdom, the Channel Islands or the Isle of Man. However, the Panel already has had relative success in dealing with companies that are controlled outside the United Kingdom, the Channel Islands or the Isle of Man (but whose securities are listed on a regulated market) and it has done this without needing to flex the statutory powers of enforcement conferred on it in 2006. In addition, it will continue to be the role of companies’ advisers to help ensure compliance with the Code where necessary.

The consultation paper is open to responses until 28 September 2012. Once the Code Committee has considered the responses it will publish a response statement setting out the final text of the amendments to the Code. This will take effect approximately one month after the response statement is published, which is likely to be towards the end of 2012.

A decision of the Supreme Court will have broad application for the future interpretation of commercial contracts, it having unanimously held that where the Court is asked to construe an ambiguous provision in a contract, that meaning which is most consistent with commercial common sense will be preferred.

In the case of Rainy Sky S.A. and others v Kookmin Bank [2011] UKSC 50, the bank had issued advance payment bonds to guarantee the obligations of a shipbuilder under a number of identical shipbuilding contracts. These bonds allowed the buyers to a full refund of pre-delivery payments, in particular where:

the buyers exercised their right to reject the vessel or to terminate the contract; or

there was an event of default by the shipbuilder, including insolvency.

Insolvency did not, however, entitle the buyers to cancel the contract.

The shipbuilder then ran into financially difficultly, and a dispute arose as to whether the buyers were entitled to a refund of their payments in the event of the shipbuilder’s insolvency or only where the buyers terminated their contracts. The parties agreed that the wording of the bonds was ambiguous.

The Supreme Court allowed an appeal in favour of the buyers, namely that the instalments should be repaid in the event of the insolvency of the shipbuilder, on the basis that this interpretation of the wording in the bonds was the most consistent with the general commercial purpose.

In broad terms and following case law, the Court could take two differing approaches with regards to interpreting the ambiguous wording, namely:

a literal approach, with the Court refusing to take into account what would appear to have been the underlying purpose of the provision in question; or

a purposive or more liberal approach, and treating the commercial purpose of the contract as more important than the literal meaning of the language used.

The Supreme Court concluded in this case that the appropriate construction of the ambiguous wording was that which was most consistent with commercial common sense. It would have made no commercial sense for the parties to have intended that an insolvency event would not lead to repayment of the instalments under the bonds because this would mean that the security, which the bonds were meant to provide, was not available when it was most needed.

The significance of this decision extends beyond this particular case, to the construction of commercial contracts in general. As well as clarifying the approach the Court should take, the case also highlights the necessity for tight drafting which reflects the commercial intention, to order to best minimise any future disputes, as it is now clear that the Court will also consider the particular commercial purpose of the contract.